Strayer Education (NASDAQ:STRA) is in a state of a contradiction in the eyes of the market. It is treated as a “defensive” play and yet trades like it is a growth stock. To resolve this contradiction, one of these beliefs must be wrong. I would contend that both of these beliefs are wrong. The stock is not trading within fundamentals and is more likely to be valued lower (lower multiple, lower reported earnings) in the quarters ahead.
Note: before proceeding to read further, please note that there is a SHORT position on this stock in my kaChing virtual portfolio. This portfolio and its activity is being followed by over 300 other users.
Strayer education reported better than expected earnings for Q1/2009. The results are as follows:
- Q1/Revenues ended March 31, 2009 + 28% to $124.5M
- Net Income $47.6 M, up 34%
- Operating income margin 38.2% vs 36.6% (Year-over-Year comparison)
These are certainly respectable results, and the reader would be wise to question my belief that STRA is not worth what it is currently. Margins improved due to higher tuition and enrollments.
Remember: the Jan – Mar period for 2009 was unprecedented. Many people lost their jobs. The economy was in a tailspin, and many reacted by signing up for online courses. Is this a one-time spike? If you are on the camp that “the worst is over” (which I am on), then STRA benefited from a one-time event.
Seasonally speaking, STRA may benefit from higher enrollments in September, but given the current P/E of 31, this has already been priced in the stock.
Let me take this argument a step further. How likely will these new students continue to study through the 3-year programs offered? If the economy improves, STRA will actually face margin deterioration as students drop out.
Take the new Criminal justice bachelor’s degree. While I would expect crime to increase in a bad economy (which is good for this course), just how many will stick out this course to complete the full three years?
Let me explain what I mean when I think “the worst is over.” What I mean is that the economy will still be poor for 2009, and job losses will continue to rise albeit at a less irrational pace. What’s over is the likelihood of many banks in the U.S. and in Europe failing. Therefore, companies will not be pressured to lay off as many people as they had done in January.
STRA is therefore not a “defensive” play. In fact, this characteristic will be stripped as enthusiasm for the market improves. Looking forward, enrollment will not be as strong as Q1/2009.
Debt expense as a percentage of revenues was 3.2% vs 2.5% (YoY). If students start to run out of money due to higher mortgage payments, insufficient savings, higher living expenses due to inflation, expect this figure to increase.
According to FinWiz, current EPS is $6.11. Management expects revenue growth at mature schools to be 10%. So why is the P/E 31?
Management provided a 2Q EPS in the $1.95 to the $1.97 range. Expenses have been under control and should not be expected to change (a non-risk for STRA longs).
2010 EPS estimate is $8.93. This represents a forward P/E of 21. Let me apply an equivalent management guidance of 10% revenue growth in its core business (mature locations). I’ll add a premium of 5% to account for growth in new locations. With a P/E of 15, I apply a 15% growth in 2008 earnings (of $6.11). Applying a 15x on $7.03 gives me a basement price of $105. That’s about a 200% premium over current levels.
Applying the same forward P/E of 15x on 8.93 results in a price target of $134.
My downside price target for STRA is $134. My price target range is between $105 - $134. This is based on the expectation that STRA will not see the same uptake in student enrollment at a rate priced in by the market.
Sources: FinWiz for P/E, 2008/9 earnings; seekingalpha for Q1/2009 earnings report.
Disclosure: I hold STRA short in my stock portfolio on kaChing. This portfolio is being followed by over 300 users.